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Following is a question by the Hon Cheung Man-kwong and a written reply by the Secretary for Financial Services, Mr Rafael Hui, in the Legislative Council today (Wednesday):

Question:

It is learnt that the accounts of a number of listed companies were only found to be irregular after the companies' financial hardship came to the surface and the auditors of such companies had not been able to uncover such irregularities during the regular audit exercises. On the other hand, quite a number of newly listed companies reported profits which fall far short of the profit estimates made in their prospectuses. In this connection, will the Government inform this Council whether it has assessed:

(a) how the above situations are related to the professional competence and conduct of auditors; and

(b) if the existing legislation is adequate for regulating the work of auditors; if it has, the details of the assessment; if not, whether it will conduct such assessment; as well as the plans it has to strengthen the regulation of auditors?

Reply:

Madam President,

The Government fully recognises the importance of compliance with accounting standards and disclosure requirements in preparing financial statements for listed companies. In this regard, the listed companies, the accounting profession, the Stock Exchange of Hong Kong (SEHK) and the Securities and Futures Commission (SFC) are each playing a key role in ensuring compliance. This is important for the better protection of investors.

Turning to part (a) of the question, it is important to note that the board of directors of each company have the legal responsibility to prepare financial statements that show a "true and fair view" of the financial position of the company. An auditor's responsibility is to ensure that these financial statements reflect the underlying records maintained by the company and are in accordance with acceptable accounting standards. The ability of an auditor to detect errors in conducting an audit will be undermined if these errors are caused by management fraud or other deliberate wrongdoing.

Similarly, the preparation of a profit forecast is the responsibility of the board of directors of the company to be listed. The directors are responsible to make reasonable assumptions and meet profit forecast. The reporting accountants' responsibility is to ensure that the profit forecast is properly compiled in accordance with the assumptions made by the directors.

In ensuring compliance with the Listing Rules, SEHK looks into listed companies whose previously audited financial statements do not reflect the company's financial position as of that date. In addition, the SFC as regulator of the securities market, also has a strong interest in this area. Where appropriate, both SEHK and SFC will refer cases of material misstatements to the Hong Kong Society of Accountants (HKSA) for review. In the past six months SEHK has referred 11 cases to HKSA.

We understand that HKSA is investigating into the accounts of these companies to ascertain the circumstances in which such companies had failed, and whether the auditors concerned had failed in their reporting duties. The Society has undertaken to announce the results of these investigations as soon as possible. It would be premature therefore to rush to judgement as to whether the irregularities of these companies have any relationship with the auditors involved.

Turning to part (b) of the question, we should note that in the present financial climate, it is not surprising that some listed companies will experience financial difficulties. The functioning of the existing regulatory regime for auditors should be assessed against this background.

Under the Professional Accountants Ordinance, HKSA as the self regulator of the accounting profession is vested with statutory powers to establish entry requirements for the accounting and auditing profession, specify professional standards for its members, carry out regular reviews on members' practices, conduct investigations and order disciplinary actions.

HKSA monitors the work of auditors on a continuous basis through reviews of the financial statements of listed companies as well as reviews of the practice of certified public accountants. It will initiate investigation into the affairs of its members should it have reasonable suspicion of significant non-compliance with professional standards or misconduct. In addition, the Society also acts on complaints from the public and referrals from other regulatory bodies, such as the SEHK and SFC. The Society is empowered to conduct disciplinary hearings and impose sanctions on its members, including reprimand orders, penalties up to $500,000 and removal from its professional accountant register. There are precedents of major accounting firms being subject to disciplinary actions.

In general the existing regulatory arrangements for the auditors have served us well. However we should not be complacent. HKSA, the market regulators and the Government are making renewed efforts with a view to improving the professional standards of auditors. This will help strengthen corporate governance, especially among the listed sector, so that we are better equipped to meet new market challenges.

In this regard, HKSA has required that with effect from 1999 all its members must undertake a minimum of 40 Continuing Professional Development hours every year to keep themselves abreast of current developments in professional and economic matters.

To improve the corporate governance of listed companies, SEHK published in April 1998, as part of the Code of Best Practice under its Listing Rules, a guideline to set up an 'audit committee' within each listed company. The audit committee should be appointed from amongst the non-executive directors of the company's board to ensure objectivity and independence. Its principal duties include the review and supervision of the company's financial reporting process and internal controls. This guideline came into operation on 1 January 1999. A listed company will be required to provide an explanation in its annual report should it choose not to establish an audit committee.

At the same time SEHK is negotiating a Memorandum of Understanding with HKSA on the division of regulatory work in respect of listed companies.

Moreover the Administration is prepared to provide immunity to auditors who see it necessary to report suspected fraud or malpractices to regulatory authorities. This has been a subject of extensive consultation in the past two years. We shall include relevant legislative amendments in the composite Securities and Futures Bill scheduled for introduction into this Council before the end of this year.

End/Wednesday, March 24, 1999

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